The Difficulties of Investing in China

As China President Hu Jintao visits President Obama and the rest of the US, most of the attention will be focused -- in our view, wrongly -- on the dollar / yuan exchange rate, as well as more important matters like the global availability of high-tech vital rare earth metals, of which China controls more than 95% of the world's export trade - a figure likely to remain more of less constant for the next five to ten years at least.

Underlying the currency concern, of course, is the issue of JOBS -- which the US has failed to produce, despite a so-called / self-styled / alleged "recovery", but which are, at least for the moment, more than plentiful in China at ALL income levels.

Given this, it's not very likely President Obama or most other corporate / government officials with whom Hu is likely to meet will bring up what might be called "the other side" of the ever-growing and more complex US / China economic relationship: the difficulty US and other investors have in bringing money INTO China, where, of course, they create even more jobs.

So in our ever-contrarian spirit here at EconomyWatch, we thought the occasion of Hu's US visit was a great time to look at this -- generally under-appreciated -- aspect of China's economic relations with the rest of the world.

From a cattle ranch in the country’s northeast to a gym in Beijing, Jade Gray has been involved in his share of start-ups since arriving in China from New Zealand in 1996.

He is therefore no stranger to China’s many rules on investing in the country.

“It’s a very laborious process, and there a lot of hoops to jump through,” said Mr. Gray, who began his fifth venture, the Gung Ho! Gourmet Pizza Factory delivery service, with a fellow New Zealander a year ago.

China may be the world’s second-largest economy after the United States, and the largest exporter, but the renminbi remains almost unheard of in international currency flows.

“There are technically very few ways for renminbi to flow out of China,” said Christopher Xing, who advises on Chinese taxes at KPMG in Hong Kong.

That is because when China began opening up its economy in the 1980s, it decided against opening its currency market to avoid the kind of money inflows and outflows that can blunt a central bank’s ability to manage an economy.

Given that, while it may be many companies’ dream to sell to the 1.3 billion Chinese, it's not surprising that getting money into China to set up is a formidable hurdle.

“This is the biggest challenge in terms of setting up your business,” said Mr. Gray, who started Gung Ho! with an initial investment of $400,000.

A foreign company cannot convert a single dollar into renminbi - whether to open a bank account, hire an employee or lease an office - without first getting investment approval from the local branch of the Ministry of Commerce.

“If you want to bring in money into China for investment purposes, you need to have a project approved by the government,” said Flora Sun, director of the China office in Shanghai of the consulting firm Brian Cave International Trade.

The process is different for investors who want to buy Chinese stocks.

Once largely off limits to foreigners, China began in 2003 allowing some foreign investors to become qualified foreign institutional investors. For businesses that want to start ventures in China, the easiest path may be to first set up a sales representative office, experts advise. But that means not being able to book any sales inside of China.

Another route is to set up a joint venture with a Chinese partner.

The third option is to establish a wholly foreign-owned enterprise.

Approval depends on whether the investment is in an industry prohibited for foreign investment, like, say, agriculture or publishing. If the proposed investment is not restricted and is below $300 million, it can be approved by the municipal or provincial authorities.

Anything larger has to go to the Ministry of Commerce in Beijing. If the proposed investment is in a restricted industry, the investment limit for local approval falls to $50 million. Once the investment is approved and a business license is issued, the company has to get approval to convert its investment into renminbi from China’s State Administration of Foreign Exchange.

And only after getting that can a foreign company open a local bank account and start spending money in China. This presents some investors with a Catch-22: they need to invest renminbi to get approvals but cannot until they have approval to invest.

One solution, Mr. Xing said, is to open a pre-investment bank account. This allows companies to spend up to $100,000 to set up their businesses and get investment approval, with the amount spent counted toward the new venture’s approved investment capital.The approved investment amount is an important number. It represents the maximum amount of capital the company can bring into China and convert into renminbi.

If a foreign company wants to bring in more, it needs to get the investment RE-approved, through largely the same process, which can take up to two months. As a result, some companies tend to apply for a larger amount of investment than they think they need, just in case, which leaves them with a surplus of cash sitting in a Chinese bank.

But another strategy is to mix start-up investment capital with loans from the company’s owners, Mr. Xing said. The larger the investment, the more China allows the new venture to borrow. So while investors of $3 million or less can borrow only up to 30 percent of their total approved investment, those of $30 million or more can borrow up to two-thirds of their start-up capital, he said.

Whatever the mix, the company cannot convert any of its approved investment without proper documentation to show the bank.

Investors need to show their bank an invoice or service agreement to convert their deposits and spend them. Companies in China have to provide documentation — an invoice and customs declarations - to convert renminbi into foreign currency to purchase goods abroad.

In recent years, China has begun a pilot program that allows banks in a number of cities and provinces to settle cross-border trades in renminbi, part of a gradual effort by China to promote the use of its currency in international trade.

But the transactions have to be approved by the State Administration of Foreign Exchange, and the counterparties must be in Asia, Mr. Xing said.

China also regulates how foreign companies can repatriate their profit. Companies need to make sure they have paid corporate taxes first. China then requires that they put 10 percent of their earnings into a general reserve. They can then apply to pay the remainder as dividends to their foreign owners by showing their books and a board resolution.

China charges a 10 percent withholding tax on the payment, a relatively low amount in Asia, according to experts. China also charges a 10 percent withholding tax on interest payments, as well as a 5 percent business tax.

But there is no tax on repayments of loan principal, which is one reason why Mr. Xing says repaying shareholder loans can be more advantageous to foreign companies from a tax perspective than paying out dividends.

If this seems complicated, experts say, it pales next to the complexities of China’s rapidly changing business scene.

Selling pizzas topped with gourmet ingredients like grilled herb chicken and wine-soaked black currants, Camembert cheese and fresh herbs, he said, is aimed at Beijing’s increasingly affluent diners, according to this article from the New York Times.

“There’s no doing formulas,” he said of making a go of it in China. “You just shoot in the dark. That’s where experience comes in.”